KLA Corp

NASDAQ:KLAC

Earnings Call Transcript 2019-Q3

[Operator]

Good afternoon, my name is Jerome, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation Third Quarter 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Now it's my pleasure to hand the call over to your host, Mr. Ed Lockwood, KLA Corporation, Investor Relations. The floor is yours.

[Theodore Lockwood, Senior Director of Investor Relations]

Thank you, Jerome. Good afternoon, everyone, and welcome to our conference call. Joining me on our call today are Rick Wallace, our President and Chief Executive Officer; and Bren Higgins, our Chief Financial Officer. We're here today to discuss quarterly results for the period ended December 31, 2019. We released these results this afternoon at 1:15 Pacific Time. If you haven't seen the release, you can find it on our website.

Today's discussion of our financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A detailed reconciliation of GAAP to non-GAAP results can be found in today's earnings press release and in the investor presentation posted on the KLA Investor Relations website. There, you'll also find a calendar of future Investor Events, Presentations and Conferences as well as links to KLA's SEC filings, including our Annual Report on Form 10-K for the year ended June 30, 2018. In those filings, you will also find descriptions of risk factors that could impact our future results.

As you know, our future results are subject to risks. Any forward-looking statements, including those we make on the call today, are subject to those risks and KLA cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements.

With that, I'll turn the call over to Rick.

[Richard Wallace, President and Chief Executive Officer]

Thanks, Ed. KLA delivered strong results for the March quarter, finishing at the upper end of the range of guidance for revenue and above the range for Non-GAAP EPS. We achieved these results despite the near-term softening in the wafer fab equipment market, showing the resiliency of KLA's business model and the compelling value of our strategy is focused on market and technology leadership, revenue diversification and operational excellence.

We also closed the Orbotech acquisition in Q1, and work has begun to execute integration efforts and realized revenue and cost synergies. The value creation opportunity in the combination with Orbotech are compelling. We are further diversifying our revenue streams and expanding our reach in the global electronics value chain, enhancing our ability to serve new and existing customers in fast growing end markets, such as 5G infrastructure, smart mobile and automotive to name a few.

Now I'd like to point out key reasons why the combination with Orbotech is an important component of our long-term growth strategy. Orbotech shares core values with KLA, as well as a proven track record of enabling customer success, having long distinguished themselves for market leadership, innovation, technology and talent. Orbotech's market leader in each of the segments it serves, and there is no customer overlap in the PCB and flat panel markets. And there is no product overlap in the specialty semiconductor and advanced packaging business.

Now, we are serving a larger and more diversified market with a broader portfolio of products and solutions. Orbotech business diversified, serving different segments each with their own cycle dynamics. Orbotech's revenue in calendar 2018 grew 16% to $1.04 billion, with a three-year CAGR of 12%. Of note, the specialty semiconductor business grew 23% in 2018 and is poised for high growth again in 2019, against a backdrop drop of broad-based weakness electronics manufacturing.

Turning now to today's semiconductor market environment. Based on consensus industry reporting, WFE grew in the mid-teens in 2018, which is significantly higher than was previously projected. Process control intensity remain flat in 2018 in a year of strong memory investment. We are seeing higher adoption of inspection and metrology solutions for memory customers to support the 3D NAND roadmap and scaling to tighten design rules and DRAM.

EUV was also a key factor in 2018 equipment spending, including process control infrastructure and reticle and optical wafer inspection. Given the expectation that EUV investment will continue in 2019 and together with a large percentage of foundry and large spending in the WFE Mac mix. We expect process control intensity to increase in the calendar year.

The Gartner report for 2018, shows KLA held strong market share and process control. Thanks to our differentiated product portfolio, technology leadership and strong customer collaboration. Consistent with our peers, we expect WFE will be down approximately 15% to 20%, in 2019, largely due to weaker DRAM demand, NAND investment is also expected to be down in the year.

While foundry and logic investment will increase, driven by the 7-nanometer ramp, EUV development and the steady trailing edge demand to support 5G infrastructure, IoT and automotive applications. 2019 will be a dynamic and exciting year for KLA, despite the current market turbulence, we are well positioned to leverage the breadth of our product portfolio and our business execution competencies to show good relative performance in the year and emerge even stronger when the market rebounds.

With that, I'll turn the call over to Bren, for his review of the financial results. Bren?

[Bren Higgins]

Thank you, Rick, and good afternoon, everyone. Q1 was a busy quarter for KLA. We launched our new corporate brand in January, closed the Orbotech acquisition in late February, executed a $1.2 billion debt financing in March and delivered results that met or exceeded the updated guidance for the June quarter we issued on March 5 after the close of the acquisition.

Total revenue in the quarter was $1.097 billion at the upper end of the revised guidance range of between $1.025 billion to $1.115 billion. GAAP earnings per share was $1.23 and non-GAAP earnings per share was $1.80, finishing above the range of guidance. Non-GAAP earnings per share would have been $1.78 at the 14% long-term tax planning.

We are pleased with the results we achieved in Q1 and are off to a solid start for calendar 2019 consistent with our expectations. We are now moving forward in our plans for integration of Orbotech and focusing on strong execution and operations excellence across our business.

Due to the close of the Orbotech acquisition, there are meaningful differences between the GAAP results and the non-GAAP results. I encourage you to review the reconciliation between the two contained in our press release. The remainder of my comments here today are based on the non-GAAP results.

As this is the first quarter we are reporting combined results for KLA and Orbotech, we will provide income statement, cash flow and balance sheet for KLA inclusive of Orbotech in addition to customary disclosures in demand commentary. Bridge results to the original guidance we provided back in January for semi process control business, we will share details on the financial results for this business and Orbotech separately.

We are disclosing this additional information is a means for investors to better understand the dynamics of the KLA and Orbotech businesses in the stub period. Looking ahead, as we move forward in integrating the businesses, we plan to transition our disclosures and financial reporting to reflect the results and operations for KLA on a consolidated basis.

Now, for the March quarter results. As I mentioned, total revenues in the first quarter were $1.097 billion, product sales accounted for 72% of total revenues. We expect total revenue to grow about 14% at the midpoint and be in a range of $1.21 billion to $1.29 billion in the June quarter, with sequential quarterly revenue growth expected to continue through the calendar year.

For both the semi process control business and the Orbotech business, we expect the second half revenue levels to be higher than the first half. In terms of regional split of revenue for the combined company, Taiwan was 25% of revenue, China was 19%, Korea was 18%, Japan was 13%, the U.S. was 14%, Europe was 7% and the Rest of Asia was 4%.

Now I'll turn to some detail on commentary regarding demand trends in the March quarter for the semi process control business. Semi process control revenue, which includes the traditional KLA systems and service businesses was $936 million in the quarter.

The expected overall demand environment for 2019, in the semi process control market is consistent with our original view from January with KLA looking to benefit from strong foundry and logic demand growth, reasonably balanced across the year.

And with the expectation for the current soft demand environment in memory to persist throughout the year. Weak memory industry demand continues to influence our customer's caution towards their equipment investment plans. While we have some visibility into plans in this segment, they remain fluid given the current industry outlook and customer commitments could change quickly and without warning.

We remain optimistic about long-term memory equipment demand, due to raising capital intensity to deliver bit growth supply and disciplined financial management by our customers. However, due to the consolidated nature of our industry, any shift in customer delivery requirements could impact our near-term results. Semi process control shipments were $957 million in Q1, above the range of guidance of $860 million to $940 million.

As expected with the adoption of the new accounting standard for revenue recognition. The difference between shipment results and revenue for KLA is immaterial and largely a function of short-term timing dynamics. As a result, we will continue to guide and report shipments through the June quarter, but we'll move to revenue only disclosure for business units, geographic distribution and customer mix, beginning with the reporting of the September quarter.

In short, under ASC 606, the difference between shipments and revenue was not sufficiently material to warrant the cost and effort require to maintain dual reporting. We expect total shipments of $1.235 billion to $1.315 billion in Q2 with semi process control shipments of approximately $1 billion. Memory was 38% of semi process control system shipments in March and we expect memory to be approximately 47% of this mix in the June quarter.

Foundry was 54% of shipments and is forecasted to be about 41% of the total in June. Shipments to logic customers were 8% and the current outlook is for logic to be approximately 12% in Q2. The approximate distribution of shipments by product group for the semi process control business was wafer inspection was 42%, patterning was 30%, including shipments for reticle inspection, service was 24% and non-semi component inspection was approximately 4%.

Now for some additional details of results from the Orbotech businesses in the quarter. A reminder that these results are for the 39 days stub period following the February 20th close of the acquisition. Revenue was $161 million above the guided range of $145 million to $155 million for the stub period. The semiconductor device business delivered strong revenues for the first quarter and momentum is expected to continue throughout calendar 2019, driven by strength in PVD and edge applications for RF, power and advanced packaging.

This business is the market technology leader in targeted specialty semiconductor segments and is delivering faster revenue growth rates in the overall semiconductor equipment market and demand drivers include automotive, 5G investment and MEMS/sensor applications for IoT as well as growth in China.

The printed circuit board business grew 10% in 2018 and is positioned to deliver solid relative performance in 2019 compared with the broader electronics market. Orbotech is the market and technology leader in critical applications in the PCB manufacturing process, such as laser direct imaging, optical inspection for defect control and repair. The PCB division will introduce several new products in 2019 to meet the requirements of new technologies such as mSAP and flex PCB and capture the future growth resulting from increasing PCB complexity.

Additionally, the service component is an important aspect of the overall value proposition for this business and is approximately 40% of its total revenue. Similar to the semi-process control service model PCB service has a high percentage of recurring contract revenue and is focused on value-added services such as application support and software upgrades and not just basic break-and-fix services.

The flat panel display business reflects the current weak overall industry demand conditions in LCD and OLED manufacturing. This market is experiencing a digestion period is leading display customers realigned their product strategies and production capacity to shift to new technologies.

Advanced Panel design, such as high-end jumbo OLED TVs and flexible portable displays are becoming more expensive and complex to manufacture, featuring smaller pixel sizes increased pixel density in multiple layers. As the market leader in test repair and inspection solutions for FPD, our business benefits from new capacity growth, as well as from an increasing technical complexity in the next-gen display market. Though the market environment is challenging in 2019, we believe we are well positioned when the market recovers.

Turning now to financial results for the combined company. Gross margin was 60% in March, slightly better than the implied gross margin associated with the updated guidance, as product mix in the semi process control business was mostly consistent with what we modeled in January. In June, we expect gross margin to be in the range of 58% to 59%. Gross margin in the semi process control business is expected to be slightly lower quarter-to-quarter as modest volume benefit of higher revenue is offset by the expected product mix.

For KLA consolidated gross margin, in addition to expectations for our semi-process control business, the change quarter quarter-to-quarter is also the result of approximately $90 million of additional Orbotech revenue representing a full quarter of revenue for this business.

Based on our current outlook for business unit performance and overall revenue levels for the remainder of calendar 2019, we expect stronger quarterly gross margins in the second half and you should model gross margins for the combined company in the range of 59.5% to 60.5%.

As in past M&A, we see a number of opportunities to improve Orbotech gross margins over time as we leverage our global manufacturing scale shared and common supply chain, service infrastructure, and internal supply capabilities. Total operating expenses were $311 million in March and operating margin was 31.6%.

For the June quarter, we expect operating expenses to be approximately $375 million at the midpoint as we will incur a full quarter of Orbotech operating expenses and a modest increase in R&D expense in our semi-process control business.

Given our topline expectations and planned product development investment profile, we expect quarterly operating expenses to be in the range of $370 million to $375 million for the remainder of calendar 2019. I would note that OpEx includes stock-based compensation expenses Orbotech, which is previously excluded from there non-GAAP public reporting as an independent company.

Operating expense synergy planning related to the acquisition is underway and we will provide periodic updates on our progress in this area over the coming quarters. Other income and expense in the March quarter was $22 million, including the impact of the debt service to fund a portion of the transaction for the stub period.

Going forward you should model quarterly OIE at approximately $35 million principally due to the incremental debt in the capital structure to fund the acquisition and other corporate activities including our ongoing share repurchase authorization. The effective tax rate was 13% in the quarter, given the new corporate tax structure in the US and our expectations for the geographic distribution of profit, including the contribution from Orbotech, investors should continue to model our tax planning rate at 14% going forward.

Net income was $283 million and we had $157 million fully diluted weighted average shares outstanding. During the quarter, we issued approximately 12 million shares as a component of the transaction consideration for the acquisition. We are expecting weighted average share count for Q2 to be approximately 162 million shares.

Now for some highlights of the balance sheet and cash flow statement. Cash and investments were $1.9 billion and total debt was $3.4 billion. As stated earlier, on March 13th, we issued $1.2 billion of 10 and 30-year senior notes with a blended coupon of 4.4%.

Our gross leverage ratio at the end of the March quarter was 1.7 times within our target range of 1.5x to 2x gross leverage. Cash from operations was $164 million and free cash flow was $138 million. We paid an aggregate of $114 million in regular quarterly dividends and dividend equivalent upon the vesting of restricted stock units and repurchased $200 million of common stock pursuant to our share repurchase program.

We have approximately $1.2 billion available under our current share repurchase authorization. We expect to execute this repurchase program systematically over the next 12, 18 months, subject to market conditions.

In conclusion, the March quarter results demonstrated strong operating performance and relative strength for KLA and a weaker overall WFE environment. We completed the acquisition of Orbotech integration and synergy activities are underway. With a diversified end markets, market leadership across a broad product portfolio and operations discipline, KLA is positioned for strong relative performance in 2019. And what is expected to be a challenging year in the electronics manufacturing markets.

With that to summarize, guidance for the June quarter is revenue between $1.21 billion and $1.29 billion. GAAP diluted EPS of $1.90 to $1.39 per share, and non-GAAP diluted EPS of $1.55 per share to $1.85 per share. Total shipments are expected between $1.235 and $1.315 billion with semi process control shipments of approximately $1 billion in the June quarter.

Before turning the call over for your questions, we're pleased to inform investors that we have scheduled our 2019 Investor Day for Tuesday, September 2017 in Midtown, New York. We will have more details to follow in the coming weeks and we look forward to seeing you all in September.

With that, I'll now turn the call back over to Ed to begin the Q&A.

[Theodore Lockwood, Senior Director of Investor Relations]

Okay. Thank you, Bren. At this point, we'll open up the call for your questions and we ask that you limit yourself to one question and one follow-up, given the limited time for today's call. All right Jerome, we're ready for the first question.

[Operator]

[Operator Instructions] Your first question comes from the line of Timothy Arcuri from UBS. Timothy, your line is now open.

[Timothy Arcuri, UBS Investment Bank]

Thanks a lot. I had a couple. So Bren, just on the gross margin guidance 58% to 59% non-GAAP, it's a little lower than, if you just sort of do the math for the two companies. It seems like it'd be in the 60% to 61% range. So, first of all, can you sort of talk, is there like a one-timer happening in? And then sort of snap up into the '60s maybe for the back for the back half of the year? Thanks.

[Bren Higgins]

Yes, Tim, thanks for the question. So, yes, I mean this quarter, there is some just mix dynamics that are driving the margin a little bit lower than you would think. And as I said in the prepared comments that we would expect gross margins in the second half to be higher. At the end of the day on our core business, it's going to move around on product mix across the different products or is bringing revenue in it at about $255 million in the quarter.

We expected to grow in the second half as we said in the comments. And their gross margin is trending in the high 40th percentile. So, when you blend it out that we end up, but I would expect the second half margins to be higher, which is why I gave the full calendar year commentary as well that modeling somewhere between 59.5% and 60.5% for the year.

[Timothy Arcuri, UBS Investment Bank]

Okay, awesome, Bren. And then maybe, and I know probably you'll go through some of this at the Analyst Day, but can you give us maybe some milepost as the business grows into next year and the year after, sort of what the financial model looks like, and maybe just pick like $6 billion as like an annual run rate once you get to 1.5 billion quarter, what is the model looks like? What's gross margin and what is our margin look like? Thank you.

[Bren Higgins]

Yes. So Tim, I want to get away from or I want to get into to necessarily guiding out further. And so this is just need just thinking about where the numbers might line up, obviously the comments I made around product mix. Our issues that obviously would affect our performance. But, yes, I think gross margins probably settle in at those kind of revenue levels in the between 60% and 61%.

Certainly, operating expenses are going to move, according to product development requirements. And then, of course, there are some synergy opportunities that we're going to be executing. So the time-frame that we were to get to those kinds of numbers that you referred to would be a factor and all of that.

So, the way we presented in the longer term model was a couple of points of dilution related to the Orbotech transaction to our longer term model that we published, which - so I think that, when you're thinking in the mid-30 kind of percent operating margin range on those revenue levels. So, hopefully that helps.

[Timothy Arcuri, UBS Investment Bank]

Okay, Bren, thank you so much.

[Operator]

Your next question comes from the line of Vivek Arya from Bank of America. Vivek, your line is now open.

[Vivek Arya, Bank of America Merrill Lynch]

Thanks for taking my question. I just wanted to go back to the overall demand environment. I think when the year started the industry view was that WFE would be down 10% to 15% - it's down 15% to 20%, not just from you guys, but obviously from all of your peers. What's the slope of recovery here? When do you think the start to get visibility as to when we will see a recovery in overall spending?

[Richard Wallace, President and Chief Executive Officer]

Yes, this is - I'll take part of it, and then this is Rick and Bren can add in. It is true that the rate of decline, the magnitude is higher, but that's largely because December finished stronger - 28 finish stronger than - 2018 than we had originally modeled. And so if you look at what the overall numbers we're talking about for 2019.

We're still in a similar kind of range $45 billion to $46 billion with WLP. So that was really the way we're looking at that. And we'd also said in the past that this is really starting to strengthen even into the June quarter, but the second half as Bren indicated in his comments are going to be stronger for KLA, but also for the industry.

[Bren Higgins]

Yes, the only - to Rick's points, the year-over-year ratios are moving around given the strength of the finished 2018 now that everybody has reported. And so it looks like 2018 is a little bit stronger. So our view is very consistent with what we thought in January. We saw mid-40s WFE levels for the year with the March quarter being the bottom and sequential growth for the Company resuming in June and continue in the second half. So second half stronger than first half.

Foundry logic reasonably balanced across the year was our perspective. So, what's interesting is we are three months later and his played out as we thought. So, I don't think there's anything really different than what we thought a couple of months ago. And certainly, we are watching the end market dynamics and what those ultimately will mean to just given the consolidated nature of our business to our customers' investment plans. But so far, playing out as we expected a few months ago.

[Vivek Arya, Bank of America Merrill Lynch]

Thanks. And for my follow-up, China, so the demand from China, do you think that is kind of trending down in line with the overall WFE? Or are you seeing any more disruption because of trade tension or is this just an absorption period of because what they installed last year. So what I'm getting with that is that as we hopefully get some easing of tensions, do you think demand from China will improve at some point?

[Bren Higgins]

Yes, we've had puts and takes around China. We disclosed shipment profile in January that we thought to be down between 10% and 15% in calendar 2019 versus calendar 2018. And our view is pretty consistent with that. We've seen some strengthening from certain customers and we came from others.

So our general view is pretty consistent overall, so it looks like we'll see more foundry logic investment this year. And certainly, you have the OEMs that are investing both in terms of - or the need for wafer capacity materials, wafer capacity and reticle capacity.

So I would say for 2019, our views are pretty consistent thousands what we thought a few months ago. I would say that on the trade tensions, I'd say that was a factor early in the calendar year at the end of last year of uncertainty.

And now I think the way China is behaving as more just based on the way the overall industry is behaving relative to demand, and so we're seeing those plans are gated on that, not as much on concerns around trade.

[Vivek Arya, Bank of America Merrill Lynch]

Thanks. Very helpful.

[Operator]

Your next question comes from the line of Harlan Sur from JPMorgan. Harlan, your line is now open.

[Harlan Sur, JPMorgan Chase & Co]

Good afternoon. Thanks for taking my question. On Orbotech, there's been some headwinds on the display, CapEx trends this year as you guys mentioned, but the move to OLED by some of their customers should boost capital intensity for their products.

In PCB disappointing handset unit trends, but again offset by the move to things like mSAP technology and more automotive goodness there, SDD continued strong, so a number of puts and takes, but this is on the June quarter guidance and sort of backing into the full quarter March revenues for Orbotech in your comments about second half. It does appear that Orbotech will drive higher revenues versus calendar year 2018. Is that a fair assumption?

[Richard Wallace, President and Chief Executive Officer]

So Harlan, when we look at the business today, and again, we only had it for the 40 days of the first quarter. So we do expect sequential growth through the year. I would say, or Orbotech that will be in the ballpark of what they did in calendar 2018 based on what we see today, perhaps slightly less.

I think given our relative to prepare - given the environment overall for electronics in terms of just softening and digestion that's happening out there. Looks like the business has been pretty resilient for the reasons that you described. And certainly what we're seeing on the semiconductor side is that's an area of WFE where there is growth in investment. And so, we would expect to see that business grow more in a more meaningful way in 2019 versus 2018.

[Bren Higgins]

And then longer-term, Harlan, we're - we believe we're on track with the architect plan that was laid out in 2017, when you talk about the longer-term trends all seem to be very positive and we're excited about what we've seen. We think the Company is well positioned with the assets as part of KLA and we'll continue to build on the momentum, as you say FPD has had some headwinds, but there's been some good wins in the other parts of the business.

[Harlan Sur, JPMorgan Chase & Co]

Yes, absolutely. Good insights sir. Thank you. And then looking at the Gartner shared data for 2018 in your flagship optical inspection franchise. Think you guys gained about 500 basis points of market share, and I think now you guys are almost like 14x larger than your nearest competitor, and this is versus a 7x last year. So, huge drop of your competitors. Is the bar just getting raised really that much higher with like your Gen 5 tools and your updated Gen 4 platform. And then how is the momentum shaping up this year for your Gen 5 platform?

[Richard Wallace, President and Chief Executive Officer]

So I'll take part and then let Bren get into the specifics. I think you're right. I think that what we're seeing is to continued investment by our customers and the flagship products both Gen 4 and Gen 4. And so one of the things I think a couple of generations we realized is we're going to keep investing in prior generation. So for example, the Gen 4 is how to build out two, in addition to what we're seeing at Gen 5.

And I think for our customers it's the most effective way to manage their yield challenges and wrap their facilities. So we feel really good about where we are. We continue to invest strongly and as Bren will tell you, we're seeing the progress that we were hoping for in Gen 5.

[Bren Higgins]

Yes, this year's a good year for Gen 5 Harlan we expected to see multiple units adoption from all major customers, so encouraged by that. We'll probably end the year with somewhere around 30 units in the field. If I were to fast forward, obviously we need to execute over the next several months. But that's our expectation. So it's nice growth and adoption of that product line. And we introduced the next iteration on Gen 4 product is customers tried to extend that capability too.

So you're seeing a mix and match adoption profile from our customers there. We also have a new product in the laser scanning space called Voyager. And that's the adoption has been really positive on that too. So you're seeing to mix and match across the Puma platform, plus Voyager. So for the total portfolio of optical pattern inspection, it's very well positioned in the market and we would expect as you see foundry move on to 5 nanometer down the road, including what they're doing today to support 7 nanometers activities, the logic investments that are happening. We feel pretty good about the position into that product line.

[Harlan Sur, JPMorgan Chase & Co]

Yes. Nice job on the execution. Thank you.

[Operator]

Your next question comes from the line of John Pitzer from Credit Suisse. John, your line is now open.

[John Pitzer, Credit Suisse]

Yes, good afternoon, guys. Thanks for let me ask the question. As always appreciate sort of the industry backdrop color you gave in your preamble. I'd be coming curious, especially with the inclusion of Orbotech, you gave us a lot of color around what happens to the total addressable market in calendar year 2019. I'll be curious as to how you see your SAM evolving in calendar year 2019 with all the puts and take?

[Bren Higgins]

Sure. I think that as we laid out early, Orbotech we think gives us access to another $2.5 billion in overall addressable market based on their position. We think that as we go forward to combine that with what we have in the rest of our business, we're at about $8 billion this year, and that should continue to grow.

Basically, as we think about the products that are in the pipeline and things that we're working on, we think the TAM over the next few years grows, maybe another 10% beyond that $8 billion as we go forward based on new product entries and market growth. So we don't need a tremendous amount of market growth based on some of the new work that's going on and pipeline, both for KLA what was our process control business and now as we talk about our process business, which is in semiconductor and also FPD and PCB.

[John Pitzer, Credit Suisse]

That's helpful. And then as my follow-up, Bren. Just going back to the gross margin, you said in the June quarter guide there sort of a one-time mix issue. Is that just more Orbotech revenue or just going on in the mix with the core KLA business. Then as we think about the full-year gross margin, is it pretty much a linear progression September, December to get to that number Or how are we thinking about exit trajectory of gross margin and what's driving the improvement? Is this overall mix of business? Or is it you actually getting your hands on the Orbotech asset and driving some cost synergies?

[Bren Higgins]

Yes, John, thanks for the question. So, consistent with the commentary around revenue growth, we expect gross margin to improve quarter-on-quarter as we progress through the year. So on the core KLA business we saw little bit more revenue in the June quarter.

We'll see versus March and the mix of the business, particularly around reticle inspection where we've had some higher mixed mashup business and that's being offset by some fab business, which we're very happy with the penetration in performance there, but the margin profile is different. So we do see pretty wide swings around those products depending on what segment you're shipping into.

So I do think that it's all kind of coming together into a lower profile in the June quarter, and we would expect to see it improve through the second half. I would say the same thing about the Orbotech business given the rapid growth there. And certainly, over time as we execute on synergies and we're doing a lot of planning today, but we would expect to see that sort of start to flow through the model certainly around supply chain, internal supply and other things.

It will take a little bit of time for that to happen. So I think the trajectory moves that way. June is a little bit weaker with the tools that we ship or the tools that we shipped and how that profile plays out is how it influences the mix. But overtime, structurally, we feel pretty good about where the margin profile is overall on the KLA business and there's opportunities on the Orbotech side over time.

[John Pitzer, Credit Suisse]

Thank you.

[Operator]

Your next question comes from the line of C.J. Muse from Evercore ISI. C.J., your line is now open.

[C.J. Muse, Evercore ISI]

Great, thank you. Thank you taking the question. I guess another question on gross margins, just wanted to clarify the 59.5% to 60.5% commentary. Was that for all of calendar 2019 or is that expected range for the back half 2019? And as part of that, could you walk through I guess the margin contributions across the three sub-segments within Orbotech, and if you can't be terribly precise perhaps rank order highest to lowest that would be very helpful? Thanks.

[Bren Higgins]

Sure, CJ. So the guidance for the calendar year, obviously includes March and June, and then what we expect in the second half. So when you're thinking about the calendar year profile that's in the margin profile be to achieve that you need to see the margins improve in the second half.

And I would say in the upper end of the range that I provided for the full calendar year. So hopefully that helps from a modeling perspective. On the Orbotech business, I think on the specialty semi side, the easiest way to think about the three businesses, is especially the semi side tends to be in the mid-50s plus or minus, you're probably in the high-40s on PCB and you're probably in the mid to high-30s generally on FPD.

Now FPD piece has a lot to do with the business levels, given the leverage that in that model given the higher level cyclicality for that business. That's the smallest part of Orbotech, as you to think about the three businesses. So certainly over time, given the expectations of growth around the specialty side, we would expect to see the mix improve in terms of the gross margin profile.

[C.J. Muse, Evercore ISI]

That's very helpful. And as my follow up I guess at a higher level, can you talk through how you're partnering with Amichai and the rest of the Orbotech team to drive top line synergies and I think you guys so clearly see in both the specialty semi and PCB side, what kind of groups perhaps you've created and what the timeline is to start to see those revenue synergies hit the model? Thank you.

[Richard Wallace, President and Chief Executive Officer]

Sure. This is Rick. There are two things going at once. Orbotech was a successful company standalone for a number of years and has been successful in growing their business. So on the one hand, we've been very mindful of that as we began integration to let them to continue to work together as not quite separate, but continue to drive their business independently.

However, over the last couple of months, we've seen customers actually ask us for to work together and we've seen some opportunities to do that. So that's really a slow roll out. We're going to detail this in quite a bit when we come in September for our Analyst Day, and we're going to talk more about it, but it is very encouraging especially in the specialty semiconductor where we do have customer overlap, no product overlap, the customer overlap looking for more capability.

And I also think there are some customers that specialty semiconductor division was working on and the addition of KLA to the portfolio for them makes it more likely that we'll gain share and also market share there. So we think there's great opportunity. And the other business is maybe a little bit more of some cost synergies as we work through some of the operational opportunities we have there and then their supply chain, which kind of covers those two businesses also where will continue to drive that. But again, that's something we're going to lay out in more detail as we do our Analyst Day in September.

[Bren Higgins]

The other thing I'll add on that one is that, as you think about the PCB business and advanced printed circuit board technology is you are starting to see more blending between advanced packaging in PCB on the roadmap for our customers as they try to drive cost in capability improvements.

And so, certainly, we have some exposure to that space, Orbotech does as well. So we're investigating what - how that strategy might play out and certainly how technology might be applicable as we start to think about the growth exists there. So early days on a lot of this work, but certainly something we'll outline in more detail when we get to the meeting in September.

[C.J. Muse, Evercore ISI]

Thank you.

[Operator]

Your next question comes from the line of Krish Sankar from Cowen and Company. Krish, your line is now open.

[Krish Sankar, Cowen and Company LLC]

Yes, hi. Thanks for taking my question. I have two of them. First one for Bren, I don't know if I missed it, if you strip out the Orbotech revenues in March and June, is the core legacy KLA business growing? So is it like low-to-mid single, just want to get color on that, and I had a follow-up?

[Bren Higgins]

Yes, so in the prepared remarks, so against the guidance we gave in January, we guided for a midpoint on revenue of $920 million. We came in at $936 million. And then for the June quarter, we talked about shipments of approximately $1 billion. And also some comments around with 606, this transition to successfully expand that there isn't much difference between shipments and revenues.

So hopefully that gives you the color. And again, it's consistent with what we thought in terms of March being a bottom and expecting to see growth in the June quarter and sequentially for the remainder of the calendar year. So, if you think about the broader performance of the business given the mix of WFE, yes, most of the decline is driven by DRAM, into a lesser extent, the decline in NAND.

But you also have significant growth in foundry and logic. We're also seeing investments that are happening and reticle and in wafer. So, when you add all that together, our expectations is you see process control intensity improved in the year, but also that our relative performance relative to the industry should be better. So I think it's playing out the way we thought. And we're pleased with our market position and how we're seeing in the segments play out.

[Krish Sankar, Cowen and Company LLC]

Got it. That's very helpful. Bren, and then a question for Rick. It looks like you guys are getting some traction in the EUV inspection side. EUV in theory is going to replace some of the multi-patterning steps. So if you look at it on the inspection side, is it fair to assume that EUV inspection will replace some of the regular inspections and net-net it's a neutral impact for you guys? Do you think there's actually growth did you inspection?

[Richard Wallace, President and Chief Executive Officer]

Process control intensity goes up with EUV. That's clear. And it does so because of the additional requirements associated with the reticle inspection is going to just the stakes are higher with those reticles. And I also think you're going to see more focus on print call. So you're going to have more optical inspection as well.

Not to mention some of the challenges, we're going to have with overlay when they get to multi-pattern. And so I think there is good reason to believe that we'll see intensity go up over time. Now, when you think about how much of the market is really EUV at this time, it's a pretty small number. So that percentage is going to take some time to accumulate but it's definitely increase intensity.

[Krish Sankar, Cowen and Company LLC]

Thanks, Rick.

[Operator]

Your next question comes from the line of Quinn Bolton from Needham and Company. You're line is now open.

[Quinn Bolton, Needham & Company, LLC]

Great. Thank you for taking the question. Wanted to first ask on the memory side of the business. Sounds like DRAM is weak as well 3D NAND in your June comments, I think you said memory increases to 47% of shipments from 38% of shipments. Just wondering if you could give us a little bit of color, what's going on there? And then my follow-up question is on the bare wafer inspection segment. It looks like Gartner's reporting that segment increased something like 87% in 2018. How do you see that part of the business in 2019? Thank you.

[Richard Wallace, President and Chief Executive Officer]

Yes, on the shipment profile, the shipments to memory customers are higher in the June quarter. There's a couple of big projects that we expect to ship to both in the DRAM and the flash side. So I think in terms of the second half of the year, we'll see how that plays out and we'd expect increasing momentum as we move through the year, but we do have higher shipment levels to both segments of memory in the quarter related principally to two or three projects.

On the bare wafer side, we've seen a lot of growth in that business. I mean, 2018 was a great year and 2019 was flat to 2018. And it's not just the bare wafer customers as much as it's also on pattern inspection and metrology overall, which has been driven by the high levels of memory investment. So, you have capacity requirements, but you also had changing specifications for metrology and the cleanliness requirements for 3D NAND is driving a lot of investment in that product. So we would expect similar results in calendar 2019 versus calendar 2018 in that business against the backdrop of the declines in the WFE market.

Now as we move to 2020, I would expect some of that capacity on the wafer side too - those that demand on the wafer side to pull back a bid calendar 2020 still much higher sustaining level given the requirements I talked about. But we would expect for this year and to be very consistent with what we saw last year.

[Quinn Bolton, Needham & Company, LLC]

Great. Thank you.

[Operator]

Your next question comes from the line as to shear off Toshiya Hari from Goldman Sachs. Toshiya, your line is now open.

[Toshiya Hari, Goldman Sachs]

Yes, great. Thanks for taking the question. You guys provided long-term growth expectations for Orbotech when you guys announced the deal. I think it was 15% for semiconductor devices, 13% for display and 8% for PCB. Have those numbers changed at all given the developments over the past 12 months?

[Richard Wallace, President and Chief Executive Officer]

Yes. So we put those numbers are very consistent with the year 2020 model that tech had presented probably back in 2017. So look the assumptions move around, certainly these lay assumptions move around, I would say I'm probably more optimistic on the semiconductor side and a little less. So on the display side. But overall, the expectations for that business, which 2020 model I believe was $1.25 billion.

I feel pretty good about that at least today based on the path that we see to get there. Obviously, the size of these markets and how the electronics market and markets play out will influence that. But we haven't seen anything at a top level that, that we think this way this from that view that, they should be able to achieve the 2020 plan that we laid out when we announce the transaction.

[Toshiya Hari, Goldman Sachs]

Okay, great. And Bren as a quick follow-up on synergies is $50 million over the next six quarters still the right way to think about synergies from Orbotech? And I guess related to that, what sort of OpEx synergies are embedded in your June and back half guidance of $370 million to $375 million? Thank you.

[Bren Higgins]

Yes, very little is embedded. We targeted a time frame of 12 to 24 months. We're doing that work now, I think just given the timing of how those actions could play out and how you see it flow out of the model, it'd probably be - we start to see some benefit towards the very tail end of the year. So limited synergies are forecasted in the guidance again, both for OpEx and for top line. So - but our goal is $50 million, by the $50 million run rate by the end of 12 to 24 months from the transaction and we feel pretty comfortable with the ability to get there. We'll see how it plays out, I would say, it's probably more $20 million to $25 million in OpEx and maybe $25 million to $30 million in the COGS volumes.

[Toshiya Hari, Goldman Sachs]

Great. Thanks for the color.

[Bren Higgins]

Thank you.

[Operator]

[Operator Instructions] Your next question comes from the line of Patrick Ho from Deutsche Bank. Patrick, your line is now open.

[Shek Ming Ho, Deutsche Bank AG]

Thank you very much. Rick, maybe first off in your comments regarding China, you said the industry spending to be down, however, with the memory market in China going through some significant yield issues. Could you see KLA outperforming, I guess that outlook based on increasing process control intensity to help them along their development curve?

[Richard Wallace, President and Chief Executive Officer]

Yes, both things are true. We do see overall market coming down as we said memory down, China maybe a little less. And we're continue to be strong as we help them in terms of some of their aspirations about driving these new processes. So yes, we do see intensity higher there we should outgrow in China.

[Shek Ming Ho, Deutsche Bank AG]

Great. Maybe as my follow-up question on the EUV inspection side of things, you've talked about the limited availability to date, primarily on the foundry logic side of things, how do you see the memory market, particularly DRAM in terms of its adoption and how it could influence your EUV inspection bias?

[Richard Wallace, President and Chief Executive Officer]

There is some adoption there. I would say it's from our perspective, we're going to be engaged if that happens. I think like everyone, they're going to look at the cost benefit of doing that versus the alternatives probably most pronounced via formation. So I think that we're going to see the opportunities there as they come. But I would say it's much more limited in memory then relative to logic or foundry.

[Shek Ming Ho, Deutsche Bank AG]

Great. Thank you very much.

[Operator]

Your next question comes from the line of Atif Malik from Citi. Atif, your line is now open.

[Atif Malik, Citigroup]

Thank you for taking my questions. Rick, since you start to move to 7-nanometer, 6, 5, 5.5 just seems like there are just a smaller and smaller increments in terms of the shrinkage. Can you just talk about within there like $10 billion to $11 billion kind of CapEx outlook are you expecting your sales to grow as a leading foundries move in smaller steps?

[Richard Wallace, President and Chief Executive Officer]

We do. Before I want to correct something I just said, it's the storage note on DRAM, that's something that, not the VF formation. In terms of increasing intensity for the foundries, absolutely, I think the challenge for the foundries is yield at these advanced nodes. And as you know, as you push these the stress on EUV increases in terms of - or the economic viability.

So we're going to see process control intensity throughout really the supply chain, whether it's in - you have to make the reticles and that's a challenging prospect now and maybe the most challenging. So between reticle formation and the print down onto the wafer to make sure you have clean images. I think that's a challenge to make sure that the defectivity is low.

So we're seeing demand in the design sign to form these - the early tape-outs, and then we'll see it in production. So as the note scale, I think they're going to be largely driven on the economics of those nodes as it drives our customers.

[Atif Malik, Citigroup]

Okay. And then when we would at SPIE conference earlier this year, there was a discussion on stochastic defects. But the message here was that the chipmakers need help from every type of inspection equipment, whether it's e-beam or optical, just because these issues is far greater than anyone expected. Is your view on e-beam that it's still will be available as a combination to optical as part of your strategy. Is that still your strategy or you've had a changed strategy?

[Richard Wallace, President and Chief Executive Officer]

No real change. I mean, we've talked about leveraging e-beam platform to do some of the inspections on the reticle itself and that's a reticle without a pellicle just to validate the design. But when you do - when you print down and you're trying to model and manage the stochastic implications, you really need optical for that, because you need to have enough throughput to be able to cover enough area. So it's certainly going to be a blended approach by our customers and we are committed to having all the capabilities that they need

[Atif Malik, Citigroup]

Thanks

[Operator]

At this time, there are no further questions on queue. Mr. Ed Lockwood, you make continue for any closing remarks.

[Theodore Lockwood, Senior Director of Investor Relations]

Thank you, Jerome, and thank you all for joining us today. Jerome, you may conclude the call.

[Operator]

That concludes today's call. Thank you all for joining KLA Corporation first quarter 2019 earnings conference call. You may now disconnect.